What would you do if you had a little windfall come your way? Would you spend it all, or would you look for ways to improve your finances, such as paying off some of your debt? Right now, many people are struggling with this question as they decide how to use their tax return and/or their $8,000 first-time homebuyer tax credit.
Some fraction of these people will (like us) be looking to pay down their mortgage loan with their tax refund. Instead of simply paying extra principal toward their mortgage, however, there’s another option to consider… They could recast, or re-amortize, their mortgage loan.
Each approach has pros and cons, and different people will arrive at different decisions depending on their goals and circumstances.
Shortening your mortgage term
I mentioned before that you can shorten your mortgage length paying extra principle on it every month. We’ve also covered some strategies for paying off your mortgage early. Making the extra payments can cut years off your mortgage and save you tens of thousand of dollars in interest, depending on your loan terms.
For example, with most 30 year fixed rate mortgages, you pay a huge amount of interest for the first seven years or so of your mortgage. As you get closer to the end of the life of the mortgage, more of your payments go towards principal.
The primary advantage with paying off your mortgage early (aside from peace of mind) is the big improvement in cash flow. Once your mortgage payment is gone, you’ll have hundreds (maybe a thousand or two) in extra cash each month that could be used for your other financial goals.
What is mortgage re-amortization/recasting?
Mortgage re-amortization is basically a loan modification that changes your monthly payments. Amortization refers to the paying off of a debt in installments over a set period of time. Instead of simply paying extra money towards principal, you may be able to use that money to reduce you balance due and re-calculate your monthly payments.
The advantage of re-amortization is thus that you can get lower monthly payments and have a slight, ongoing improvement in your household’s cash flow. It won’t be as big of a change as if you paid off the mortgage early, but you’ll get an immediate benefit.
You could then use the difference in the monthly payments to build your savings, pay down other debt, or build a retirement nest egg. Not all lenders offer this option, however, so check with your lender to see if you can recast your loan.
You should also check on what sort of fees are involved with, and what restrictions might be in place. Some lenders will allow you to do this multiple times, while others offer this as a one time deal.
Recasting vs. shortening your mortgage
You really have to know your plan for your mortgage and run the numbers to figure out the best option for you. If you plan on consistently over-paying your mortgage, then recasting won’t provide much of a benefit. If, however, you plan on just making a big payment once, and would rather reduce your monthly mortgage expenses instead of shortening the overall timeframe, then re-amortization may be something to consider.
Shortening your mortgage can have bigger costs up front as you’re putting more money in now, but your pay off will be on the huge decrease in your monthly expenses when it’s finished. You will also have saved tens of thousands of dollars in interest payments. Only you and your family have all the information needed to run the numbers properly and decide which option will put you ahead.
Sticking with paying off the mortgage early
When I looked at the numbers, recasting our mortgage wouldn’t make much of an impact on our cash flow. It would reduce our monthly housing expenses by only $50 or so. We think it would be better to just focus on going ahead and paying off our mortgage early. By focusing on getting a conservative mortgage amount, we’ve already created a little bit of a buffer between income and expenses.
I’d love to hear your thoughts on this. If you had (say) $10,000 to pay down your mortgage, what would you do? Would you recast and go for lower monthly payments or would you shorten your mortgage? Why?